Introduction – Export Businesses and Canada’s GST/HST
System
Export-oriented businesses in Canada play a vital role in
facilitating Canada’s international economic presence and
economic growth. An export business engaged in repackaging and
distribution of goods abroad, rather than on manufacturing or
production, may be able to benefit from beneficial sales tax treatment under Canada’s Export
Distribution Centre Program (the “EDCP”). Enacted in
2000, the Export Distribution Centre Program was designed to
benefit export business models strictly focused on redistribution
services. What export business models may qualify for authorization
under the Export Distribution Centre Program, and what activities
may threaten that authorization once obtained, can involve
complicated tax rules and principles. It is vital that any
registrant seeking authorization speak to an expert Canadian tax
lawyer on eligibility for authorization and how best to structure a
business to benefit from favourable sales tax treatment under the
Export Distribution Centre Program.
Canadian GST/HST Rules for Businesses
In Canada, GST/HST is generally charged on taxable supplies
purchased in or imported into the country. GST/HST will be payable
on a supply purchased domestically by a Canadian business at time
of purchase, while for imports GST/HST will generally be payable at
the time of import itself with limited exceptions under Part IX,
Division III of the Excise Tax Act. To prevent the inevitable
increase in costs that would result were every supplier along a
supply chain required to pay GST/HST, an off-setting input tax credit
(ITC) is offered to registrants on non-exempt supplies. That input
tax credit will be equal to the GST/HST that the registrant paid on
supplies used as part of the registrant’s commercial
activities. The input tax credit system is designed to prevent
cascading taxation in the hands of businesses, and to shift the
GST/HST charged on a supply onto the final consumer.
This sales tax system, as it applies to export-oriented
businesses, is far from ideal. Generally speaking, the value-added
to a supply or to inventory by an export business focused on
redistribution is minimal. That same export business will
nevertheless be responsible for paying GST/HST on any goods for
export purchased domestically and internationally. Export-oriented
businesses may be entitled to claim and receive input tax credits
on GST/HST paid on supplies, but the delay in time between payment
of GST/HST and receipt of the credit often creates cash-flow
issues. The Export Distribution Centre Program was principally
enacted in order to provide some relief from cash-flow issues among
appropriate export-oriented businesses.
Benefits of the Export Distribution Centre Program
Subsection 273.1 of the Excise Tax Act, defining the scope of
the Export Distribution Centre Program, authorizes the Minister of
National Revenue (the “Minister”) to grant qualifying
applicants authorization under the Export Distribution Centre
Program. An applicant granted authorization by the Minister through
the Canada Revenue Agency (the “CRA”) is entitled to
issue Export Distribution Centre Program certificates when
purchasing supplies or inventory domestically on a zero-rated basis
(so long as the total consideration for property purchased with the
certificate is at least $1,000), and internationally on a
non-taxable basis. A zero-rated supply is effectively taxed at a
rate of 0%, meaning that the authorized purchasing business will
not be subject to GST/HST payable on the value of purchases made in
Canada or from abroad. In the context of the export industry, the
Export Distribution Centre Program is a substantial boon and helps
to avoid significant cash-flows from becoming trapped as a
consequence of Canada’s GST/HST remittance system.
An applicant who successfully applies for authorization with CRA
will be entitled to issue Export Distribution Centre Program
certificates for a period of up to 3 years from the effective date
of authorization of the applicant. Certification under the Export
Distribution Centre Program is therefore not a permanent
designation, and thus an authorized business must continue to
qualify for the program by re-applying for each 3-year period under
the Program.
Qualifying for the Export Distribution Centre Program
In order for an applicant to qualify for the Export Distribution
Centre Program under the Excise Tax Act, that applicant must
satisfy a number of specific conditions. First and foremost, the
applicant must be a registrant for the purposes of collecting
GST/HST and must be both actively and exclusively engaged in
commercial activity. A registrant meeting these criteria must also
be reasonably expected to satisfy three additional conditions
pertaining to the nature of its commercial activities:
- The registrant must not engage in “substantial alteration
of property”; - The registrant must refrain from contributing excess value to
consumers’ goods through processing activities; and, - The registrant’s percentage of revenue from export activity
must be reasonably expected to be at least 90%.
“Substantial Alteration of Property”
First, the registrant must not engage in “substantial
alteration of property” in a given tax year. “Substantial
alteration of property” in this context has several
complicated definitions under the Excise Tax Act, and includes:
- Any manufacturing or producing activities, or an engagement
with another person to manufacture and produce, property in a tax
year; - Any processing (including adjustments, alterations, assembly
and any similar ‘basic service’ to a supply) undertaken by
the registrant in a tax year which results in finished inventory of
the registrant, if: - The percentage value-added attributable to non-basic services
with respect to that inventory exceeds 10%; and - The percentage total value-added with respect to that inventory
exceeds 20%.
- The percentage value-added attributable to non-basic services
In essence, a registrant is prohibited from contributing too
much value through its services to finished inventory designated
for export. A registrant can surpass one percentage limit on
value-added attributable to services, but not both, and only if
those activities do not qualify as either manufacturing or
producing. Thus, a registrant can contribute more than 10% to the
value of the supply through non-basic services, so long as the
total value-added with respect to inventory does not exceed 20%. On
these grounds, it is plainly clear that only export businesses
focused on redistribution will be able to qualify for tax benefits
under the Export Distribution Centre Program.
Contributing Excess Value through Processing Activities
Second, in order to qualify under the Export Distribution Centre
Program, it must be reasonably expected of the registrant that
either:
- The registrant’s percentage value-added attributable to
non-basic services concerning customers’ goods will not exceed
10%; or - The registrant’s percentage total value-added with respect
to customers’ goods will not exceed 20%.
That is to say, a registrant involved in processing goods for
consumers must refrain from surpassing both of the above
percentage value-added limits. Just as with the “substantial
alteration of property” condition, a registrant is permitted
to surpass one percentage limit under the Export Distribution
Centre Program.
Percentage of Revenue from Export Activities
Third, the registrant’s revenue from export activities must
be at least 90% of the registrant’s total revenue generated by
commercial activity in Canada for the registrant’s tax year.
The Excise Tax Act enumerates what qualifies as “export
revenue” for the purposes of evaluating a registrant’s
percentage of revenue. The Excise Tax Act includes in the
definition of “export revenue” any consideration
resulting from sale of domestic inventory outside of Canada, any
sale of “added property” (which includes, among others,
packing materials and components for inventory to be sold to
consumers) used by the registrant in order to process Canadian
property for export, and any processing, storing and distribution
services for exports of property offered to other persons.
Pro Tax Tip – Revocation of Certification under the Export
Distribution Centre Program
Once a registrant’s top Canadian GST lawyer has obtained authorization
from CRA under the Export Distribution Centre Program, it is
expected that the registrant will remain a qualifying entity over
the 3 years that the authorization remains valid. Under subsection
273.1 of the Excise Tax Act, CRA is entitled to revoke a
registrant’s authorization where the registrant fails to comply
with any conditions that may have been attached to the
registrant’s authorization under the Export Distribution Centre
Program, or the registrant fails to comply with any GST/HST
provisions of the Excise Tax Act. CRA may also revoke the
registrant’s authorization where CRA reasonably expects
that:
- The registrant will engage in substantial alteration of
property in that tax year; - The registrant will surpass the prescribed limits to percentage
value-added attributable to customers’ goods in that tax
year; - The registrant’s export revenue percentage will be lower
than 80% for that tax year.
Alternatively, the registrant may instead suffer an automatic
deemed revocation to take effect at year-end where any of the three
above conditions are breached by the registrant. A deemed
revocation of a registrant’s authorization will disbar that
registrant from re-applying for authorization under the Export
Distribution Centre Program for at least one fiscal year. Where CRA
has revoked the registrant’s authorization for breach of
authorization conditions or any GST/HST provisions, the registrant
will be disbarred from re-applying under the Export Distribution
Centre Program for two years. It is therefore vital for an export
business to actively monitor the nature of operations in order to
ensure that the business will not risk running awry of these rules.
If you are a registrant considering making an application under the
Export Distribution Centre Program, or are an existing authorized
registrant seeking to learn how better to structure your operations
to avoid a potential revocation, then you should consult with one
of our expert Canadian tax lawyers.
FAQ: GST/HST Digital Service Tax Requirements: Non-Resident
Businesses
What is the Export Distribution Centre
Program?
The Export Distribution Centre Program is a system of tax relief
available to qualifying export-oriented businesses in Canada. An
HST/HST registrant authorized under the Export Distribution Centre
Program is generally entitled to purchase supplies and inventory on
a zero-rated basis domestically and non-taxable basis
internationally through use of Export Distribution Centre Program
certificates. The purpose of the Export Distribution Centre Program
is to alleviate the potential cash-flow issues caused by the time
delay between payment of GST/HST on purchases and satisfaction of
input tax credit claims.
What are the conditions for qualifying under the Export
Distribution Centre Program
A qualifying applicant under the Export Distribution Centre
Program must be a registrant for GST/HST remittance purposes in
Canada. The registrant must also satisfy three additional criteria:
the registrant must not engage in “substantial alteration of
property,” the registrant must not contribute excess value to
customers’ goods through its commercial processing and
distribution activities, and at least 90% of the registrant’s
yearly revenue must be “export revenue.”
Can I lose my certification under the Export
Distribution Centre Program?
A registrant may have its authorization under the Export
Distribution Centre Program revoked at the discretion of CRA under
certain conditions, or may suffer a deemed revocation automatically
at fiscal year-end depending on that registrant’s commercial
activities. Revocation of a registrant’s authorization will
generally follow from violating the principles that initially
qualify a registrant for the Export Distribution Centre
Program.
Whether you qualify under the Export Distribution Centre Program
will depend on additional factors, including whether your business
activities exporting to China comprise 90% or more of your yearly
revenue from operations as well as to what extent the vehicles are
serviced before being exported to Canada. The nature of any
services performed on those vehicles will be very relevant to your
ability to qualify under the Export Distribution Centre Program.
You should speak with a top Canadian tax lawyer if you are looking
to optimize your export business by submitting an application for
authorization under the Export Distribution Centre Program.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.